Japan, Korea React Coolly to U.S. Debt Warning

By

Martin Vaughan And

Gaurav Raghuvanshi

Updated April 19, 2011 11:47 a.m. ET

The Japanese and South Korean governments, two of the largest holders of U.S. Treasury bonds, offered strong support for U.S. government debt Tuesday after Standard & Poor's Ratings Services overnight warned it may downgrade the world's biggest borrower's AAA-rating.

The Chinese government, the world's biggest buyer of U.S. Treasurys, kept silent. An adviser to the central bank said China should diversify its more than $3 trillion of foreign-exchange reserves to acquire resources and technology needed for the real economy, reiterating a common theme, though the remarks didn't appear to be in response to S&P's decision to cut its credit rating outlook on the U.S. government to "negative" from "stable."

"The U.S. is taking various steps on the fiscal front, and basically we continue to believe that U.S. Treasurys are an attractive product for us," Japanese Finance Minister Yoshihiko Noda said at a regular news conference.

ENLARGE

Mr. Noda's view was echoed by Japanese Economy Minister Kaoru Yosano, who said that U.S. government bonds will continue to garner investor support globally.

"A lot of investors from all over the world still want to buy Treasury bonds," Yosano said at a separate news conference.

An official at South Korea's Ministry of Strategy and Finance said Korea's holdings of U.S. Treasurys are "very small" in absolute terms and won't be affected by S&P's warning on the U.S. debt.

The Korean official, who declined to be named, said U.S. fiscal problems aren't "new" and won't pose a serious threat to the global markets unless the U.S. economy turns worse rapidly, disrupting capital flows in the global financial markets.

The comments from the Asian governments indicate some of the largest holders of U.S. debt are unfazed by the ratings agency's warning, and aren't rushing to shift their holdings away from U.S. Treasurys. That could ease concerns that the S&P move may act as a catalyst for a faster diversification in Asia away from the dollar.

Many Asian governments have large U.S. bond holdings, mainly a result of large trade surpluses and dollar-buying interventions in the foreign-exchange market to keep their currencies from strengthening. In that respect, Asian authorities have a huge stake in the U.S. Treasury market remaining stable.

China is far and away the largest holder of U.S. debt, with $1.154 trillion of Treasurys as of the end of February, even though it pared those holdings by $600 million earlier this year, according to U.S. government data.

As recently as Monday, People's Bank of China Governor Zhou Xiaochuan said that China needs to diversify its foreign-exchange reserves, implying that China may buy less U.S. Treasury debt. On Tuesday, PBOC adviser Xia Bin echoed that sentiment in a note on Sina Corp.'s microblogging service Sina Weibo.

The PBOC and the State Administration of Foreign Exchange, a unit of the Chinese central bank that is in charge of China's forex reserves, on Tuesday both declined to provide an immediate comment on the S&P announcement.

Japan is the second largest holder of U.S. debt, with $890.3 billion in U.S. Treasury holdings at the end of February, according to the U.S. Treasury Dept. Korea held $31.2 billion in U.S. Treasurys.

The Bank of Korea in its annual report released March said it is diversifying its overseas investments to include assets denominated in major currencies other than the U.S. dollar, including the yen, euro and the U.K. pound.

Japanese institutional investors are also major holders of U.S. debt. An executive at Meiji Yasuda Life Insurance Co., Japan's third-largest life insurer by assets, said S&P's action is unlikely to affect the credibility of U.S. Treasury bonds because the U.S.'s AAA rating remains unchanged.

"We will examine movements in interest rates, and more importantly foreign-exchange rates. We are not planning to change our initial allocation plan significantly," said Yasuharu Takamatsu, deputy president and chief executive of the insurer's investment group.

Asian stock markets and some risk assets like the Australian dollar fell Tuesday in the wake of the S&P announcement.

Yields on U.S. 10-year Treasurys rose .01 percentage point to 3.3892% in Asian trade Tuesday.

Economists said a duller sheen on U.S. Treasurys could result in lower borrowing costs for Asia-Pacific nations down the line, but it is too soon to know if fiscal woes in the U.S. will result in a broad selloff of U.S debt.

"Over the medium term, if fiscal consolidation does not appear to be credible in the U.S., yields in other parts of the world may get lower than would otherwise be if investors diversify away from U.S. Treasurys," said Matt Hildebrandt, a sovereign-debt analyst at J.P. Morgan. "That may make debt financing cheaper in the region and there may be greater issuance of dollar bonds."

But Mr. Hildebrandt warned not to "get too pessimistic" on U.S. debt, as U.S. economic fundamentals remain strong and any diversification away from Treasurys would be stretched out over a long period of time.

Australian government bonds and, over the long-term, JGBs in particular would gain from a shift away from U.S. Treasurys, said Bin Gao, a rates strategist at Bank of America Merrill Lynch.

"Any concern over U.S. Treasurys, even a small diversification, will help Australian government bonds to out-perform," he said. He sees little impact in the short-term on Japanese debt, but said if U.S. Treasurys are less attractive down the road, it will "prevent JGB yields from rising too high" as Japanese bonds gain as an alternative.

While the timing of the S&P announcement came as some surprise, the underlying U.S. budget troubles are well known to the market. The U.S. debt burden has soared above $14 trillion in the wake of the global financial crisis and the U.S. response.

Song Seng Wun, an economist at CIMB, said the S&P announcement was "nothing unexpected and it was only a matter of which rating agency would do it first."

"There may be some knee-jerk reaction if other raters make similar announcements," he said.

—Andrew Monahan in Tokyo, In-Soo Nam in Seoul and Aaron Back in Beijing contributed to this article.

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